The Paulson Bail-Out: The Worst Option…

So how is everyone doing? Are things great or what?! In all seriousness, at the risk of making a ridiculous understatement, this is a pretty tumultuous time in this country. There have been a couple of requests (thanks Booty Juice) for a post about the proposed $700 billion bail out, so I thought I would take a stab at it. A preliminary agreement was reached by the White House, the Treasury, and the House and Senate this weekend on the infusion of $700 billion via Henry Paulson and the Treasury Department. There have been some pretty strong words used to describe the Paulson proposal, socialism being among the most acute and divisive. Now, I think Leadcritic has remained successfully apolitical, even in this hotly contested campaign year, and I don’t want to change that now. I will also preface this post with the fact that I consider myself to be one of the more fiscally conservative people I know. I am not a fan in the least of taxes or government intervention in a free market economy. That said, we, as a country, need to ask ourselves what will the price be if the government does not provide this $700 billion?

Hopefully at this point we all agree this is no longer a $700 billion Wall St. bail-out. This situation has transgressed well beyond the limits of white collar, blue-blooded Wall St. profiteers. If you didn’t catch the article a week and a half ago from the New Your Post, “Almost Armageddon,” read it now. According to the author, on Thursday, Sept. 21st “The market was 500 trades away from… the Dow… collaps[ing] to the 8300 level – a 22% decline!” Folks, Black Tuesday, October 29, 1929, only saw a 12% drop in the DOW on that day. What saved history from potentially repeating itself was the Treasury stepping in and injecting a quick $105 billion of liquidity. We were very, very close to financial doomsday just the week before last and we are far from being out of the woods.

So, today, when we talk about the proposed bill before congress this week for a $700 billion infusion of liquidity, make no mistake about it, it is a bail out. But it is not bailing out Wall St. this is bailing out all of us. This is about our jobs, our parent’s jobs, middle-America and our everyday, functioning economy, not golden parachutes to the robber-barons at Goldman Sachs.

At this point it is academic to debate on what got us here; for example would more regulation in the mortgage industry prevented this from happening (no!)? The alternative is a financial crisis the likes that this generation has not seen. So when you talk about financial wizards such as Warren Buffett who have called the turmoil in the markets “economic Pearl Harbor,” supporting the bail-out, then I am afraid that I would tend to value his opinion more than any politician – regardless of their party affiliation – using the topic as a grand stand for their re-election bid. Buffet said recently:

“I think the Treasury will pay back the $700 billion and make a considerable amount of money,” Buffett said, adding that if he had $700 billion on the government’s terms to buy distressed assets, he would. “Unfortunately, I’m tapped out.”

Don’t get me wrong, I am not without reservation. After all, the bulk of the agreement that was reached this weekend was penned by Barney Frank, one of the most liberal members of congress, if not the most liberal. Say what you will about their politics, liberals are typically not the friend of business. Also, the structure of the bill would give what could be called a constitutionally questionable amount of authority to Paulson as to how and where the money will be used. But again I stress the idea that, if we do nothing, then the potential outcome could be catastrophic. We have already seen what became of Washington Mutual. And as I am finishing this, reports are coming through of the purchase of parts of Wachovia by Citi. To paraphrase a quote by Winston Churchill, this bail out plan is the worst option, besides all of the others.

So my recommendation is this. The biggest barriers to this bill passing in the House today and the Senate on Thursday are my fellow Republicans. They are against this for a myriad of reasons, and most of them probably good. This level of government intervention goes against the fabric of fiscal conservatism. But it is necessary. To stave off a financial implosion the likes that this country has never seen, this capital infusion needs to be passed. I urge you to reach out to your congress people and ask them to vote in favor. I kind of enjoy this industry and I want to remain working in it.

To preface, I think that some sort of intervention IS in order. However, I think the Bush administration and Bernanke totally miscalculated on this one. First off, the initial draft of the bill was a barely 3 page blank check. This is an election year, and in the height of election season, and that just was not going to fly for a lame duck president who has ALREADY thrown away $700B for a stupid war in Iraq. So, regardless of whether you agree with me on anything else, you have to concede that these guys miscalculated – even with extraordinary circumstances, you can’t expect congresscritters who are trying to get reelected in 6 weeks to get behind that.

I am actually happy that this bill failed, although as I said something is in order. The reason I’m happy this bill failed is that I want something that at least guarantees that this won’t be a highway robbery.

There have been lots of quotes from the government ministers who were in charge in Sweden when the banking crisis hit and Sweden nationalized its banking industry. How did they handle it ? Well, first off, the government took a huge equity position in the banks so that the future upside would be returned to the taxpayers. In addition, this sends the right message – “you screwed up, we’re going to absorb the losses, but now we own you” which is what SHOULD happen in this situation.

Since nearly all of what is happening is based on the level of confidence of people in the markets, this begs the question : would the markets have reacted so negatively if there was never any bailout bill on the table ? Has all the chicken little talk combined with the inability to get the rank and file GOP behind the bill actually caused a self-fulfilling prophecy ?

I think so. In order for this bill to have passed it needed certain buzzwords that would help the average conservative representative sell it to his constituents – and that doesn’t mean simply “executive compensation limits.” It means talking about punishment (investigating misdeeds), equity stakes in participating institutions (warrants). Regardless of the details this kind of language was necessary to get this bill through.

As crazy as he is, Mark Cuban had an interesting idea on his blog about all of this. What if the government bought the assets and then created an ETF fund for the assets purchased and invite the market in. Much better transparency for people to believe in, doesn’t favor wall st. players with friends in high places, etc. If the market is to be our guide, we can’t turn away from it in the darkest hour.

Great article, A Lead Buyer. It basically spelled out what I was trying to say… only it was effective. I guess that’s why he writes for the WSJ.

Booty, you are obviously a bright dude, but I feel like you may be mixing up political frustration with facts. You keep labeling this bail out plan as a folly of the Bush Administration. While Paulson was a Bush appointee, this current plan that was voted down in congress was authored as much by Paulson’s friend, Barney Frank, as it was Paulson. The bill that was voted down yesterday did indeed include an equity position for the money that the government (or we, the taxpayers) provided. As the author of the WSJ article wrote, “I am figuring Mr. Paulson could wind up buying more than $2 trillion in notional value loans and home equity and CDOs for his $700 billion.” So, while it is like any other investment – a risk – it is an investment nonetheless. This is, as I see it, the root of the problem. We have a perception problem. We need to stop calling it a bailout and call it what it is, an investment into our credit system to restore it back to health.

I’m not buying the idea that the government would be able to acquire 2T of securities for 700B. If the author is correct, the hedge funds and sovereign wealth funds (Dubai, etc) would be stepping in to provide the liquidity in the absence of the Fed. And, if the article is correct, then the Fed shouldn’t need 700B to unstop the crunch, it should be able to do it by using the discount window (which I thought already was open to these institutions sitting on illiquid CDOs).

When I say “Bush Administration” I mean exactly as you have said – Paulson is Treasury Secretary and Bush appointed him. The only political point I’m trying to make is that the usual rationality about solving a crisis can’t be expected in a very politicized environment just prior to a big election. In other words, politics IS a part of solving this perception problem in the debt markets, and nothing is going to change about that until after the election. I guess what I’m saying is that, I don’t see any version of this bill passing before the election, because there are just too many vested interests in kicking it down the line.

Now having better understood your point, Booty, unfortunately you make a very good one. But I do hope your wrong and something useful gets done before the election. If the market is any indication that it will happen, then today is good news as we are about halfway back from yesterday’s losses.